The textbook says one thing about tariffs and exchange rates. The dollar spent 2025 saying another. Closing the gap between the two has become one of the more instructive lessons in international economics, and it carries practical weight for importers, exporters, and anyone holding dollar-denominated assets.

The Standard Theory: Tariffs Should Lift a Currency

The conventional model is straightforward. When a country raises tariffs, imported goods become more expensive, so domestic demand for foreign products falls. Because buyers need foreign currency to pay for imports, weaker import demand means weaker demand for those currencies, which pushes the home currency upward. A second channel reinforces this: if tariffs are read as a sign of stronger domestic production or higher returns on local assets, foreign capital flows in, and that inflow raises demand for the home currency as well.

Economists at the Tax Foundation noted ahead of the April 2025 tariff rollout that taxes on trade carry implications domestic taxes do not, precisely because they can shift the relative value of currencies. The expectation, drawn from both theory and most historical episodes, was appreciation. Research summarized by CEPR describes currency appreciation as a robust theoretical prediction that is also commonly observed in practice.

What Happened Instead

The dollar fell. Across the first half of 2025, it lost more than 10% of its value against a basket of other currencies, weakening against the euro, sterling, and the yen. The dollar index, which tracks the currency against major peers, dropped close to 10% over the full year. The decline did not arrive smoothly. It came in short, sharp bursts, the first during the disorderly rollout of reciprocal tariffs in April 2025, a pattern that Brookings analysts described as unusual for a currency traded as widely as the dollar.

That outcome appeared to invert the textbook. Understanding why requires looking at the assumptions the textbook quietly makes.

Why the Dollar Moved the Other Way

Two factors did most of the work, and both relate to conditions the simple model leaves out.

The first is retaliation. The standard appreciation result assumes tariffs are imposed unilaterally, with trading partners standing still. They did not. China announced retaliatory tariffs of 34% on all US goods imports in early April 2025, and other partners signaled their own measures. Open-economy models account for this: when tariffs are met with retaliation rather than absorbed quietly, the currency tends to weaken rather than strengthen. Through that lens, CEPR researchers argued the post-tariff dollar decline was less of an anomaly than it first appeared.

The second factor is uncertainty. A January 2026 working paper from the National Bureau of Economic Research drew a sharp distinction between the two: tariff increases on their own push a currency toward appreciation, but tariff policy uncertainty pulls it toward depreciation, and the second effect can overturn the first. When the rules of trade keep shifting, the United States becomes a less predictable place to invest. Capital that might have flowed in under the appreciation story instead hesitates or exits, a dynamic investors labeled the “Sell America” trade through 2025.

Tariffs Are One Input, Not the Only One

Currency value never responds to a single lever, and the 2025 episode coincided with other pressures. The Federal Reserve cut interest rates through the year, reaching a target range of 3.50% to 3.75% in December 2025, which narrowed the rate advantage that had propelled the dollar to multi-decade highs in January 2025. Persistent fiscal deficits and questions about the trajectory of federal debt added to the strain. Morningstar analysts characterized the weakness as cyclical and policy-driven rather than evidence of structural collapse, pointing to slowing growth, narrowing rate differentials, and waning confidence in macroeconomic policy as overlapping causes.

Tariffs, in other words, did not act alone. They entered a system already in motion and interacted with monetary policy, fiscal credibility, and global capital flows.

What It Means for the Dollar’s Standing

The slide reopened debate about the dollar’s role as the world’s reserve currency, though the data counsel caution against sweeping conclusions. IMF figures put the dollar’s share of disclosed global reserves at roughly 56.92% in the third quarter of 2025, down only slightly from the prior quarter and still far ahead of the euro near 20%. Brookings analysis found no clear decline in reserve managers’ dollar allocations once exchange-rate valuation effects are stripped out. The pattern points to gradual diversification rather than displacement, constrained by the absence of a viable alternative.

For businesses, the practical takeaway is that a tariff’s effect on prices and on the currency can pull in opposite directions, and the net result depends on how partners respond and how steady the policy itself proves to be. A tariff designed to strengthen a currency can end up weakening it when retaliation and unpredictability enter the equation.